Margin trading offers investors an opportunity to amplify their potential profits and earn extra returns through strategic efforts. With a diversified portfolio, a trader can use smart cross margin to help lower the risk of liquidation and enjoy a much larger gain. This article will guide you through all of the basic concepts of Margin Trading and how to deploy Smart Cross Margin to better diversify your portfolio while effectively controlling risk amidst market volatility.
Understanding Margin Trading
In finance, the margin is the collateral that an investor must deposit with their broker or exchange to cover the credit risk the holder poses for the lender. Margin trading refers to using borrowed funds to pay for a purchase. Key concepts of margin trading are leverage, margin, collateral, and liquidation.
- Leverage – Leverage simply means borrowing funds to make a trade. If a trader wants to buy $5,000 worth of Ethereum (ETH) at a leverage level factor of 5x (multiple of 5), they only have to pay $1,000 themselves, and the remainder ($4,000) is borrowed from the exchange. The value of the collateral based on the current market price, minus the borrowed funds, is known as equity.
- Margin – As mentioned above, margin is essentially collateral. There are two types of margin requirements: initial margin and maintenance margin. When a trader wishes to open a position (to borrow funds from the exchange), they must deposit initial collateral. As the market price of an asset fluctuates in real time, the equity changes accordingly. If the equity level falls below a threshold – the maintenance margin, the trader will get a margin call. Now they have to choose between selling some/all of their positions or putting more funds into the account to bring the equity level back.
- Liquidation – If the trader fails to meet a margin call, the exchange can sell the trader’s margin and use the acquired funds to pay down the loan. This process is referred to as liquidation.
What is Cross Margin in Crypto Trading?
There are two popular types of margin trading – isolated margin and cross margin trading. In essence, these trading strategies represent two sides of the same coin, providing investors with unique strengths and weaknesses. This article, however, focuses on cross margin trading only, but we will guide you through all the basic concepts to completely understand a cross margin’s nature.
Isolated Margin
An isolated margin is a margin assigned to a sole single position and cannot be shared across different positions. When an investor opts for an isolated margin option, they will not have to worry about affecting other positions in their portfolio due to a single position’s margin deficiency or liquidation. If the investor fails to meet the margin call for a position and must liquidate assets, this will not affect their remaining positions.
Cross Margin
Cross margin, on the other hand, allows traders to spread their margin balances across different positions. This way, gains from a position (or some) can be used to cover margin deficiency in other positions. The main benefit of a cross margin strategy is that, in lots of cases, it could help prevent margin calls and forced liquidation of a losing position.
Let’s take a small example right here to illustrate the concepts of Isolated Margin and Cross Margin.
Suppose that investor Q wants to buy 4 different cryptocurrencies, which are Ethereum (ETH), Bitcoin (BTC), Toncoin (TON), and BOOK OF MEME (BOME) (says investor Q are a big fan of meme). Investor Q opened 4 positions respectively, one using isolated margin (ETH), and the other three using cross margin option (BTC, TON, and BOME).
When the market goes up, all four assets gain profits, and there is no margin call, so investor Q is just fine with his revenue. Now presume that ETH and BTC positions experience losses, driving them below their maintenance margins. Investor Q cannot meet the calls for both of these positions, and since ETH is an isolated margin position, it cannot use the shared margin available to the BTC, TON, and BOME positions, so the ETH one is liquidated. By contrast, BTC is a cross margin position, so it can use the shared margin among BTC, TON, and BOME collectively to replenish its margin and avoid liquidation.
Advantages of Smart Cross Margin
Smart cross margin enables investors to offset against margin requirements for positions in opposite directions (long & short positions) across several product types (for instance, spot margin, futures, and perpetual futures). If traders could deploy smart cross margin strategy, they can reduce the overall margin requirements while improving capital efficiency.
Positions in opposite directions
If investors opt for a long position, they buy and hold the assets, expecting that they will accumulate over time. Conversely, a short position means short-selling the assets (buy and hold for the right timing and sell to benefit from the differences).
Essentially, the long position gains/loses when the asset price goes up/down, and the short position gains/loses when the asset price drops/rises. This opposition allows traders to use the profits of one position to compensate for the margin deficiency of the other one.
Different product types
There are various financial instruments that can be traded based on the underlying asset. Let’s take Bitcoin BTC as an example. For BTC, the product types mentioned include:
- Spot Market: The actual buying and selling of BTC for immediate delivery.
- Futures Market: Contracts to buy and sell BTC at a predetermined price at a specified time in the future.
- Perpetual Futures Market: Similar to futures market, but without an expiry date, allowing traders to hold positions indefinitely.
By using smart cross margin, traders may need to post less collateral for their trades, as the system recognises the hedging effect of their positions across different markets. With lower margin requirements, traders can use their capital more efficiently, potentially increasing their trading capacity and profit potential. Additionally, effective use of cross margin can help in managing risk more effectively, as it provides a more comprehensive view of a trader’s overall exposure.
When is a Smart Cross Margin Used?
Smart cross margin is often employed by traders with intricate portfolios. These portfolios see long and short positions across spot and futures markets for hedging purposes. A professional trader always has plan B for any investment. Consequently, they might have a short futures position to hedge a long position in spot. A smart cross margin helps maintain these short positions, avoiding forced liquidation where various positions are balanced out.
